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November 20, 2008

Acceleration or Panic?

One day your grandchildren will ask you what it was like to live through the crash of 2008, and the only appropriate response will be, "Which one?" From late September to the October 10 low, the S&P 500 fell 32%. After a sharp rebound into early November, equities began another steep decline which so far has chunked off 25% of market cap. The big question after today's session is, "Are we witnessing downside acceleration or terminal panic?"

index chart

It certainly feels grim, and everyone with whom I've talked the last couple days used words like unimaginable, scary, and disastrous... or they just frowned and shook their heads... but something tells me we'll see one more nasty spill with record volume to end this phase of the bear. We may even see the monster spill and snap back during one session. Perhaps tomorrow will be another October 10. Who knows?

What I do know is that when the next rally begins in earnest, it is going to be unbelievably violent. For example, if we have a quick plunge to SPX 650, we could see the market rebound to the 850 pivot line in a matter of hours. To save you from whipping out your calculators, that rally would constitute a 30% move. So even though I may continue to position myself short depending on intraday setups, I will nibble on more longs on any further weakness. Currently, I hold minor positions in SLW, BP, RJA, and UYG. The UYG was added a few seconds before the close today.

Speaking of acceleration and panic, I commented in the weekend post that one should hope the volume spike in Citi shares respresented panic rather than acceleration, noting that if C broke down hard, it would be a bad omen for the market. Well, we all know how that turned out.

stock chart

At this point it's obvious we are going into a depression. I don't think the point is debatable, though some of the vacuous commentators who also denied the housing bubble may try. Numerous newsletter authors and bloggers... including yours truly... have looked to the 1930s depression as a blueprint for how this bear market will unfold, namely a monster crash followed by a 40-50% multi-month rally which then rolls into a tortuous decline to deeper lows. However, I've been second guessing this analysis, primarily due to the differences in monetary policy between the two periods. The U.S. entered the 30s with the central bank continuing to deflate the money supply. This year, the Fed has inflated like never before. We have even outdone the enormous efforts of the JCB in the early 90s, and that's saying something.

Perhaps the market will play out like the 1930s... in real terms. However, with the printing presses going full bore, I do not think we should ignore the possibility that the current bear market plays out like the 1970s in nominal terms. In terms of fading expectations, what would surprise people more than a 18-24 month rally back to all-time highs followed by a repeat of 2008? There are two points of which we should be aware related to this latter blueprint. First, it is conducive to the market feeling out a low between here and the high 600s. Second, the return to highs would be an inflationary phenomenon rather than wealth creation, ergo we traders would be better off owning commodities than stocks.


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